Pembroke Concentrated Fund Commentary

The Pembroke Concentrated Fund (“PCF”) posted strong absolute and relative performance in the third quarter of 2021, compared to its benchmark, the Russell 2000 Index (“R2000”), which declined.  On a year-to-date basis through September 30, 2021, the PCF gained in absolute terms, but lagged the Russell 2000 Index.

	3-Month	YTD	1-Year	3-Year	Since Inception, annualized	Since Inception, cumulative
PCF A, CAD	7.36	9.92	33.46	17.60	20.82	100.09
PCF A, USD	5.08	10.61	40.30	18.44	19.82	94.08
PCF F, CAD	7.05	8.96	31.91	n/a	23.89	53.50
PCF F, USD	4.77	9.64	38.67	n/a	26.65	60.26
R2000, CAD	-1.68	12.49	41.06	9.96	12.13	52.14
R2000, USD	-4.36	12.41	47.68	10.54	11.04	46.79
S&P 500, CAD	3.40	16.00	24.18	15.38	15.41	69.16
S&P 500, USD	0.58	15.92	30.00	15.99	14.29	63.21

FTSE Russell is a trading name of FTSE International Limited (“FTSE”), Frank Russell Company (“Russell”), FTSE TMX Global Debt Capital Markets Inc. and FTSE TMX Global Debt Capital Markets Limited (together, “FTSE TMX”) and MTS Next Limited. The Russell 2000 is a market cap weighted index that includes the smallest 2,000 companies covered in the Russell 3000 universe of US-based listed equities. The index is designed to be broad and unbiased in its inclusion criteria and is recompiled annually to account for the inevitable changes that occur as stocks rise and fall in value. Russell refers to the various indices copyrighted and trademarked by the Frank Russell Co. The S&P/TSX Composite is the headline index for the Canadian equity market. It is the broadest in the S&P/TSX family. The S&P/TSX Completion Index is comprised of the constituents of the S&P/TSX Composite Index that are not included in the S&P/TSX 60 Index. The index was formally the S&P/TSX MidCap Index. The FTSE TMX Indices comprise of a series of benchmarks which are designed to track the performance of bonds denominated in Canadian Dollars (CAD). The FTSE TMX Canada Universe Bond Index is the broadest and most widely used measure of performance of marketable government and corporate bonds outstanding in the Canadian market.

Two dynamics were principally responsible for PCF’s solid performance in the quarter.

First, the market’s underlying behaviour favoured PCF’s approach to high-quality growth stock investing.  The rally in lower-quality stocks (i.e. slow growing, highly indebted, and lower-margin businesses) that characterized much of the first half of the year stalled.  Higher quality businesses, like those that populate PCF, protected capital and gained in value despite the market’s absolute decline.  This market-level style shift led to roughly 25% of PCF’s outperformance in the quarter.

The remaining 75%, however, was due to several portfolio management decisions made in the second and third quarters.

• First, the team added significant weight to long-time holding Monolithic Power Systems (“MPS”) when the stock was punished by supply chain fears gripping the broader semiconductor market.  MPS, one of the highest quality semiconductor businesses on the planet, has gone on the offensive and aggressively grown share during this well-publicized chip shortage.  As the market grasped MPS’s improved position, the 20% decline in the stock was quickly followed by a 60% gain.
• Second, we re-established a position in Paycom, a PCF Hall of Fame stock that exited the portfolio early in Q1 when its long-term value equation no longer met our requirements.  Following our sale, the stock declined roughly 25% as interest rate fears punished high growth software stocks.  This significant valuation reset, combined with an opportunity-expanding new product suite, increased our conviction in the stock’s risk/reward, and led to our decision to re-initiate a position.  Thankfully, the market soon agreed with our outlook and rerated the stock up 40% from our purchase price.
• Finally, we added weight to Tecsys, a long-time Pembroke holding but relatively new PCF position.  Tecsys is a dominant vertical market software company focused on healthcare and complex distribution businesses.  Caught up in the same macro fears that punished Paycom, Tecsys declined 40% from Q1 highs only to rebound 40% following a strong, but consistent, earnings report.

These were all examples of Pembroke acting decisively when our quality businesses went on sale.  Furthermore, this represents the benefit (and risk) of more concentrated portfolios.  Individual decisions have more potential to move the needle.   

Going forward, we remain excited and optimistic about PCF’s portfolio of high-quality growth stocks.  Our stocks are growing faster than the market, with healthier balance sheets and margin profiles, have strong competitive positions, and aligned management teams—all hallmarks of Pembroke portfolios.   

Portfolio Characteristics

Pembroke believes that a portfolio of stocks containing the following attributes, over the long-term, should better protect capital in down markets and outperform in up-markets.  Our holdings consistently show faster growth, higher margins, higher returns and are better financed and more aligned with investor interests as compared to the market. 

Metric	Comment	Strategy	Russell 2000
Price/NTM Earnings	Lower Value	32.1x	26.6x
NTM Sales Growth	Higher Growth	18.5%	16.6%
Gross Margin	Similar Margin	45.4%	44.3%
Operating Margin	Highter Margin	11.0%	3.3%
NTM Earnings Growth	Higher Growth	29.6%	24.2%
Beta	Lower Volatility	0.68	1.00
Standard Deviation	Lower Volatility	18.7%	21.1%
Return on Equity (ROE)	Higher Quality	17.4%	5.3%
Return on Invested Capital (ROIC)	Higher Quality	11.8%	2.6%
Net Debt to NTM EBITBA	Lower Leverage	0.2x	1.8%
Insider Ownership	Higher Alignement	7.4%	4.3%

Q3 Contributors and Detractors

Two stocks that contributed positively to performance during the quarter

Shares in Paycom (“PAYC”) easily outperformed the market on the heels of strong Q2 earnings results.  PAYC added more new customers than expected, and importantly increased its traction on the high end of the market serving larger scale enterprises.  The company continues to execute in both good and bad macro environments, taking share from incumbents and further innovating on its industry-leading human capital management software stack.  Characterized by an enormous market opportunity, a widening competitive advantage, top-class financial metrics, and an aligned and competent management team, PAYC should exit the global pandemic as a much stronger enterprise than when it entered.

Monolithic Power Systems (“MPWR”) comfortably outperformed the market following strong earnings results and the market’s realization that the company’s multi-year growth opportunity remained intact.  Despite production challenges affecting the broader semiconductor market, MPWR has excess capacity that, when coupled with its superior product attributes, is allowing it to take share and secure new business.  The company remains one of the highest quality semiconductor businesses in the world and is a core holding of PCF. 

Two stocks that contributed negatively to performance during the quarter

Stoneridge (“SRI”) stock came under continued pressure this quarter as the automotive industry’s ongoing semiconductor and broader supply chain constraints led to a disappointing earnings report. Although the company did not provide an intra-quarter update, monthly sales data and auto manufacturer updates on future production expectations indicate that earnings expectations for 2021 and 2022 are too high. That said, long-term demand for cars and trucks remains steady, and SRI’s position as a provider of advanced safety, communications and electronics systems is improving. SRI has one of the best growth profiles—coming out of the current supply chain challenges—of any major North America automotive parts supplier. We remain focused on the company’s long-term growth profile and its competitive position, and we believe SRI maintains sufficient balance sheet strength to weather this storm. 

Albany International (“AIN”) underperformed the market in Q3, as the surge in Delta variant COVID-19 cases had a negative impact on companies and sectors tied to a reopening of travel and the economy. AIN manufactures critical components on the majority of narrowbody aircraft engines for both Airbus and Boeing. While the market sold commercial aerospace names in the quarter, we remain optimistic about the mid-term and long-term growth prospects for AIN. The company is a differentiated, mission-critical supplier of parts that improve fuel efficiency and reduce environmental emissions for commercial aircraft. As the world re-emerges from COVID-19, the growth in Albany’s end markets should be brisk. We view Q3’s dip as a buying opportunity for a high-quality, core holding in the portfolio.

Disclamer

Commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value, reinvestment of all distributions and do not take into account sales charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.

Performance is reported for both PCF A-Class and F-Class units in Canadian Dollars, net of transaction costs and net of all other fees, excluding management fees. Management fees are charged directly to unitholders based on their assets under management, except for Class F units, which are charged to the Fund. Periods greater than one year have been annualized. The performance for the portfolio and benchmark index are measured using the “time weighted” rate of return methodology.

The Pembroke Concentrated Fund was converted from a pooled fund to a mutual fund on April 1st, 2020. For the period this Fund was a pooled fund, the expenses would have been higher if the Fund was a prospectus mutual fund. The above information is for the purpose of providing some insight into the performance of the Pembroke Concentrated Fund. Commissions, management fees and expenses all may be associated with mutual fund and pooled fund investments. Investment performance assumes reinvestment of dividends and capital gains and is net of transaction costs and net of all other fees, excluding management fees. Performance results will be reduced by the fees incurred in the management of the fund. No assurance can be given that an investor will not lose invested capital. Past performance is not indicative of future returns.

 

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